Stock Options & Investing: What You Need to Know

Jon Stein

CEO & Founder

In most cases, having company stock shouldn’t influence the overall asset allocation of your portfolio--unless you’re a top exec at a big company, with more than 10 percent of your net worth in stock.

We often get questions about holding company stock or options, especially if you work at a technology company: How should these figure into your portfolio, your short- or long-term plan?

Stick to the plan

In most cases, for most people—no matter which industry you work in—you want to stick to normal investing rules in terms of how you would allocate your investing portfolio.

If we use someone who works in technology as an example, you wouldn’t need to reduce the tech stock holdings in your portfolio just because you’ve got company stock (unless you’re a bigwig at an established tech company like Google or Apple).

In fact, whatever industry you’re in, the following chart helps to explain how you can think through the role company stock plays in your investing strategy. Since we can’t address every situation, consider these rules-of-thumb.

If you work at a start-up…

1. Let’s say you work at a typical tech startup or growth-stage company (e.g. VC-funded, between 1-1,000 employees, up to ~$100mm revenue) and you have company stock. Your company is a blip in the big picture of the markets, most definitely not yet in the S&P 500, and likely not even in the tech indices. Meaning: Your company’s performance isn’t likely to correlate highly with the rest of the tech sector.

Even if tech stocks have a great year, how much is that likely to help your company’s performance—20 percent? Or maybe your company has a great year and your business quadruples in size. Is the tech sector also going to quadruple? Unlikely. So much depends on your company-specific execution and luck that the correlation is low. Low correlation is what we look for when we talk about diversification. The bottom line: Because there is low correlation between your individual company and the tech sector overall, owning tech stocks or options will not reduce the diversification of your overall portfolio.

2. Even if you have more than 10 percent of your net worth in company stock/options (you got in early, you’re a founder, you’re a beast at contract negotiations—or you don’t have other investments yet), the same logic as #1 applies. Think of your company stock as uncorrelated with your investment portfolio. You shouldn’t reduce the other tech holdings in your portfolio because of your company stock, because the performance of a small tech company isn’t going to correlate highly with the tech sector as a whole.

You’re in the big time…

3. If you’re at a big tech company, like Apple, Google, or Intel, with less than 10 percent of your net worth in company stock, that’s a small enough stake that you could keep the tech portion of your equity allocation as you normally would. These companies are going to be highly correlated with the tech sector: they might make up 10 percent of the index, and their fortunes are going to correlate more highly with each other and the market. A bad year for Apple might mean bad year for Intel—and bad year for tech companies overall. Still, 10 percent of your net worth ain’t a ton. It’s not worth adjusting your allocation.

4. The one instance where you might want to have less tech stock in your portfolio is if you work for a big player and you’ve got more than 10 percent of your net worth in company stock. Then, yes, you’d probably have the tech sector covered and you’d want other sectors in your mix of equities.

Note that ideally you wouldn’t want to have 10 percent or more of your wealth in company stock, anyway. Think about Enron, Groupon. You already depend on your job for your income and benefits; you don’t want to count on it for your future security. That’s a pretty big gamble. Best to divest when you’re able.

If you’d like to discuss or want more detail, you can email me directly at jon@betterment.com.

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Jon Stein is the CEO and founder of Betterment. Passionate about making life better, and with his experience from his career of advising banks and brokers on risk and products, he founded Betterment in 2008. Jon is a graduate of Harvard University and Columbia Business School, and he holds Series 7, 24, 63, and is a CFA charterholder. His interests lie at the intersection of behavior, psychology, and economics. What excites him most about his work is making everyday activities and products more efficient, accessible, and easy to use.

4 thoughts on “Stock Options & Investing: What You Need to Know”

Aren’t there special rules for companies that work for certain financial firms such as banks and hedge funds? I was always under the impression that legally, their employees were somewhat limited in what investment vehicles they could use.

Steve, there are special rules for service providers with inside information of firm activities, such as lawyers or investment banks might have. There are also rules for investment professionals who might be able to manipulate markets or otherwise profit from knowledge of customer trades. Those situations are different than the one described here, where an employee owns a piece of, and is exposed to, the success of his or her own company.

“Even if tech stocks have a great year, how much is that likely to help your company’s performance—20 percent? That would mean a 20 percent correlation (which is low).”

This is just no where close to being true at all. If every year that “stocks have a great year” my company stock also went up 20% then the correlation would be 1.0!!! If I do well when the market does well then that means the correlation is actually very high. How well I do doesn’t matter at all. The amount of market “performance” that trickles down to me has nothing to do with correlation. If we use that same logic then:

“Even if tech stocks have a [BAD] year, how much is that likely to [HURT] your company’s performance — [NEGATIVE] 20 percent? That would mean a [NEGATIVE] 20 percent correlation”

Clearly if both the market goes down and my company goes down the correlation is again high. And it’s certainly not negative, which would imply that my company stock and the market actually move in opposite directions. All that matters is if they are moving togther in the same direction, not how much they move relative to each other.

“…the performance of a small tech company isn’t going to correlate highly with the tech sector as a whole.”

Uhmmmmm were you guys around for the Dot-Com bubble or would we rather just forget that ever happened. In the late 90s the market performance was very strong and every little dot-com company that had an idea, a URL and zero revenue was going public. The stock prices of these small tech companies were soaring and options were worth a fortune. The tech sector, the market and the small startups were all doing phenomally well and the dot-com folks along with everyone else were making a killing. Then it all crashed. In 2000 the party came to an end, markets sold off and the tech sector in particular did terrible. The Nasdaq 100, the 100 biggest tech firms, declined nearly 80%! And similarly the stock of all these small start-ups were now completely worthless. Anyone still holding on to their company stock was now broke and everyone including non-tech folks did poorly. Furthermore how many new tech company IPO’s were happening in the early 2000s… basically none.

So it seems pretty clear that a small tech company’s performance is indeed very highly related to the market and the tec sector as a whole and that the correlations are in fact not zero and are actually probably pretty high.

I think most readers will have read and understood this correctly, that the correlation between a small company stock and the market is low. The point is that so much depends on your company-specific execution and luck that the correlation is low.

I think you may be confusing one data point with the general rule. In general and over time, the performance of one small tech company will not be highly correlated with the performance of the market or even a tech index. In the specific moment you mention, 1999-2000, I would agree that several small tech companies failed at once – and correlations may have increased. But one would have been wrong to form an all-tech portfolio based on the run-up of 1995-1999, just as one would be wrong to form a no-tech portfolio after the crash.

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